Advisor's Sale Considerations

Ideally, the independent trustees and the advisor's owners/managers have a trusting, communicative relationship that permits an open discussion of the business issues affecting the advisor. A decision to sell should not surprise the independent trustees. Before proceeding, the advisor's reasons for the sale and expectations should be understood by the independent trustees. Typical questions which should be answered by the advisor for the independent trustees include:

• Economic and personal: Is the sale necessitated by competition? Inadequate financial resources? Diversify finances? Concern about future economic conditions? Family/intergeneration succession issues? Technology threats? Attracting and retaining key employees? Increased investment research or distribution expense required to retain or increase portfolio assets? Lost enthusiasm?
• Employees: Will the acquirer demand the retention of "star" employees as a sale condition? Will key employees remain with the advisor when they learn that the advisor will be sold?
• Fund shareholders: Would fund shareholder be better served if there are additional investment opportunities? Are liquidations causing significant capital gains tax that reduce investment performance? Will recent investment performance accelerate liquidations?
• Risks: Will the fund shareholders liquidate when they learn about a pending sale? What if the sale plans are leaked prematurely? What if the sale aborts after if is announced? Are there any skeletons that could be discovered during due diligence of the advisor? Are all of the advisor and fund's records in order to facilitate due dilligence?

Planning for the Sale

A successful sale requires planning, planning, planning. The independent trustee can provide critical guidance by compelling the advisor to have "ducks in a row" before entertaining any offers or even responding to a causal inquiry. Before initiating the sales process:

• Engage special counsel for the Fund. The fund should have experienced mutual fund counsel independent from the advisor's counsel since the objectives of the advisor and independent trustee diverge during the sales process. Experienced fund counsel assists the trustees in understanding their duties and provide advise on issues that protect the fund, its shareholders, and the independent trustees themselves. Engagement of fund counsel before initiating of the sales process is essential.
• Protect key employees of advisor. Key employees should be taken into confidence and offered retention agreements. It is very difficult to replace a key employee during the sales process and unprotected but vital employees are visible for poaching or may seek new opportunities because their future employment is uncertain. Since such retention agreements are vital to protect the fund, the independent trustees should satisfy themselves that the terms are propitious. The sale process can not proceed without their knowledge and participation.
• Determine ideal acquirer. Agreement with the advisor on the characteristics of a potential acquirer prior to initiating the sales process permits the advisor to focus on seeking an appropriate acquirer that will be acceptable to the independent trustees.

Sales Process

Although the independent trustees are divorced from the effort by the advisor to ferret out and negotiate with a suitor, they have several explicit duties.

1. The acquirer needs to execute a confidentiality agreement with the advisor and the fund as a prerequisite to the release of any non-public information on the advisor or the fund. Fund counsel and the independent trustees should review and approve this agreement.
2. The acquirer submits initial due diligence materials to the independent trustees to determine if the acquirer is both (1) qualified to serve as a manager/distributor and sponsor of the fund and (2) is of sufficient financial strength and stability to be able to effectively carry on the current advisor's responsibilities. These should include basic corporate and financial information and a general summary of the proposed business and marketing plans for the fund, including any proposed changes to the portfolio management. Also included should be any disclosure on changes in either the fee structure or service to the fund or its shareholders. Examples of additional information supplied to the independent trustees include changes to: 12b1 distribution plans, existing fund's trustees, retention of employees, office locations, and compliance activities. Generally, the new investment advisor is precluded from raising fees for a minimum of two years from the date of acquisition. The independent trustees might negotiate additional scale down break points in the advisory fee schedule so as to ensure that some demonstable benefit accrues to the fund shareholders from the change of control.
3. After reviewing the information supplied by the acquirer, representatives of the acquirer meet the independent trustees to answer questions. When the independent trustees are satisfied with the acquirer, then the advisor enters into an acquisition agreement subject to the usual conditions with an acquisition. One obvious condition is shareholder approval of the investment advisory agreement. The independent trustees are not privy to most of the terms of the acquisition. However, independent trustees need assurance from fund counsel of certain contractual obligations of the acquirer. These include a joint defense agreement, a Directors and Officers Liability policy (a so called "tail" policy) covering the independent trustees for three to five years, and an indemnification agreement from the acquirer.
4. The independent trustees and fund counsel review the proposed investment advisory agreement prepared by the acquirer and, if acceptable, execute it.
5. When the new investment advisory has been approved by the independent trustees, it is submitted to the fund shareholders to vote at a shareholder meeting in a proxy statement. Approval and distribution of proxy materials to shareholders, scheduling the shareholder meeting, and its conduct are subject to the SEC proxy rules. The independent trustees attend the shareholder meeting along with the advisor and acquirer to answer questions. Assuming that a majority of the fund shareholders concur with the proposed advisory agreement, a change of control of advisors will proceed.

Second thoughts after concluding any transaction are natural. But an independent trustee who has understood the reasons for the sale of the advisor and participated in the determination of the characteristics of an ideal acquirer and was satisfied with the potential acquirer's responses should be emotionally satisfied with the outcome. Consequently, independent trustees should believe that their duty of care to the shareholders has been discharged.